Advantages of Roth IRAs
Money invested in a Roth IRA grows tax free (with exceptions noted under Disadvantages) and distributions after age 59 ½ (and after a seasoning period of 5 years) will be tax free.
The principal invested in the Roth IRA can be withdrawn at any time for any purpose without penalty or taxes.
Money earned by investments can be withdrawn early for qualified purposes, e.g., $10,000 to purchase a first home (specific rules apply).
Unlike a traditional IRA, if you do not need the money, you do not have to begin withdrawals at a specified age, and you can continue to let it grow, for the benefit of heirs.
In estates large enough to pay estate taxes, Roth IRAs provide specific benefits.
For more information on these and other advantages, please consult the sources listed below, other sources on the Internet, and your financial advisor.
Disadvantages of Roth IRAs
The funds you invest in your Roth IRA are after-tax money, and may be subject to Federal income tax, state income tax (if you live in a state with an income tax), self-employment tax and/or Social Security tax (under some circ*mstances).
In other words, contributions to Roth IRAs do not reduce a taxpayer's adjusted gross income on which they will have to pay taxes.
If you have a high income (not likely for a kid) your eligibility to contribute to a Roth IRA phases out.
You can contribute a maximum of $5000 in 2010 and 2011 (while persons over 50 can invest $6000).
Some foreign countries will tax earnings from their countries such as stock dividends, and these taxes will have to be paid even for equities held in a Roth IRA.
When you retire, you may move to a state that does NOT have an income tax. Thus the fact that your withdrawals are tax free anyway provides no advantage over having a regular IRA but then you still would be subject to Federal income tax on those withdrawals.
If you are in a high income tax bracket now (not likely for a kid), you may pay a higher tax now than after you retire.
You may not live to receive the benefits of a Roth IRA.
Tax laws may change.
Special rules apply to Canadian Roth holders with earned income in Canada.
For more information on these and other disadvantages, please consult the sources listed below, other sources on the Internet, and your financial advisor.
Useful Sources
Please see More About Roth IRAs for additional resources on this subject.
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FAQs
A Custodial Roth IRA presents a unique opportunity to foster early financial growth and education for minors. However, it's crucial to weigh these advantages against potential drawbacks, including loss of control, contribution limits, financial aid implications, and tax penalties.
What is the disadvantage of a Roth IRA for kids? ›
A Custodial Roth IRA presents a unique opportunity to foster early financial growth and education for minors. However, it's crucial to weigh these advantages against potential drawbacks, including loss of control, contribution limits, financial aid implications, and tax penalties.
Is it a good idea to open a Roth IRA for a child? ›
Why Your Kid Needs a Custodial Roth IRA, and How To Set It Up. Roth IRAs for kids are a great retirement tool, because children have decades for their contributions to grow tax-free, and contributions can be withdrawn tax-free and penalty-free at any time. Arielle O'Shea leads the investing and taxes team at NerdWallet ...
Can I contribute to a Roth IRA for my minor child? ›
A contribution to a custodial Roth IRA for Kids can be made if a minor has earned income during the year. Eligible income can include formal employment income or self-employment income. Activities like babysitting or mowing lawns can qualify a minor for Roth IRA contributions.
What is the difference between a Roth IRA for kids and a custodial account? ›
For the most part, a custodial Roth IRA operates in the same way as a regular Roth IRA. There is one main difference between these two types of accounts: Because custodial Roth IRAs involve minors, they need to have a parent (or another adult) assigned as a custodian.
Do kids have to pay taxes on Roth IRA? ›
In general, the Roth IRA is the IRA of choice for minors who have limited income now. By the same logic, it's often recommended for adults who expect to be in a higher tax bracket in the future. "If a child keeps [a Roth] until age 59½ (under today's rules), any withdrawal will be tax-free.
At what age does a Roth IRA not make sense? ›
Even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circ*mstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
How much can a child make from Roth IRA? ›
After the Roth IRA has been funded for five years, your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free. Roth IRA earnings can be used for qualified education expenses, like college tuition. Earnings distributed will be taxed as income, but there will be no penalty.
What is the best way to save money for a child? ›
Here are six ways to save for your child:
- High-yield savings or money market account.
- Certificate of deposit.
- UTMA or UGMA account.
- 529 plan.
- Trust.
- ABLE account.
If you contribute 5,000 dollars per year to a Roth IRA and earn an average annual return of 10 percent, your account balance will be worth a figure in the region of 250,000 dollars after 20 years.
A minor cannot inherit an IRA in their own name, outright. An adult, a parent or guardian or the trustee of a trust established for that minor's benefit, must be designated as the recipient since the minor lacks the legal capacity to own the account or make the necessary withdrawals.
Can you gift money to a child from an IRA without paying taxes? ›
After withdrawing the funds, if you decide to gift them to your children, consider the following: Annual Gift Tax Exclusion: For 2023, you can gift up to $16,000 per recipient without incurring any gift tax or needing to report the gift. This amount is periodically adjusted for inflation.
How to prove income for child Roth IRA? ›
Ideally your child should have a W2 or a Form 1099 to show evidence of the earned income. However, there are some instances where this may not be possible so it's important to keep records of the type of work, when the work was done, who the work was done for and how much your child was paid.
What is the best savings account for a child? ›
Summary of Best Savings Accounts for Kids and Teens 2024
| Account | Forbes Advisor Rating | Monthly Maintenance Fee |
|---|
| Bethpage Federal Credit Union Student Savings | 4.7 | $0 |
| USAlliance Federal Credit Union MyLife Savings for Kids | 4.7 | $0 |
| M&T Starter Savings Account | 4.6 | $0 |
| Alliant Credit Union Kids Savings Account | 4.6 | $0 |
1 more row3 days ago
Custodial accounts may not offer the tax benefits of 529 plans, but they can be used to fund expenses that 529 plans don't cover. If you want to set aside money for college expenses that aren't covered by an Education Savings Account (ESA) or 529 plan, a custodial account might help.
What happens to a minor Roth IRA when they turn 18? ›
Contributions to custodial Roth IRAs are not tax-deductible. At age 18 or 21, account control will transfer to the child, so it is important that they understand the value of leaving their investments as is and letting the money continue to grow.
What is the negative of a Roth IRA? ›
One disadvantage of the Roth IRA is that you can't contribute to one if you make too much money. The limits are based on your modified adjusted gross income (MAGI) and tax filing status.
What is the youngest age to withdraw from a Roth IRA? ›
Withdrawals must be taken after age 59½. Withdrawals must be taken after a five-year holding period. If you transfer your Traditional or Roth IRA at any age and request that the check be made payable to you, you have up to 60 days to deposit that check into another IRA without taxes or penalties.
